Companies are sweating the details of executive-pay disclosures in their proxy statements a little bit more this year, for fear they could be the next targets of a recent wave of lawsuits claiming boards of directors aren’t giving investors enough information.

The lawsuits, which aim to become shareholder class actions, have largely been filed by New York law firm Faruqi & Faruqi LLP. The suits seek minute details, such as the justification for hiring a particular compensation consultant, that companies have historically glossed over.

Though they consider the suits frivolous, companies are worried their proxy could be next in the cross-hairs, especially since the suits often aim to block companies from holding their annual shareholder votes.

Most of the companies sued so far are pushing for quick dismissals, saying their disclosures are already more than adequate and big investors haven’t asked for this type of information. Companies already have bulked up proxy filings significantly in response to new disclosure rules for executive pay. Even so, a handful of other plaintiffs’ law firms are starting to follow Faruqi & Faruqi’s lead and corporate attorneys are preparing.

Michael Melbinger, head of the executive-compensation practice at Chicago law firm Winston & Strawn LLP, said he spends as much as an extra hour per proxy filing he reviews evaluating whether additional minor disclosures might protect companies from such legal claims. “This is completely bogus, but no one wants to get sued,” he said. He said his firm keeps a chart of Faruqi & Faruqi claims, tracking their progress through the court system.

The lawsuits underscore a challenge companies face in complying with new corporate-governance rules established under the Dodd-Frank Act. The rules don’t provide hard-and-fast guidance on what a company must disclose. Instead, they are “principles based,” according to James D.C. Barrall, co-chair of the benefits and compensation practice at law firm Latham & Watkins LLP.

The Securities and Exchange Commission, which is still finding its footing in setting new corporate-governance standards, requires only that a company make “narrative” disclosures about pay proposals, and has made clear it expects to see some variation. Speaking to corporate directors last week, SEC Commissioner Daniel Gallagher said the agency should “not become the wrench in the works of corporate governance,” in which states and proxy-advisory firms already play a large role.

Since last March, Faruqi & Faruqi has filed more than 15 lawsuits and announced more than 50 investigations into allegedly missing corporate disclosures. The law firm claims boards have breached their fiduciary duty by excluding minute details that shareholders need to make informed decisions on key issues, such as advisory votes on executive compensation, or votes to authorize companies to replenish stock used to pay employees.

“The law requires that a proxy include a summary of the analysis relied upon by the board to make a recommendation,” said Juan Monteverde, an attorney at Faruqi & Faruqi. “We believe that information is also something that shareholders need to have.”

Similar shareholder lawsuits questioning directors’ commitment to their fiduciary duty frequently follow merger announcements. But while those suits can be built into the cost of a merger,Corporate attorneys say potential claims about disclosure shortcomings could be bottomless because of the loose guidelines surrounding the disclosures and the fact that every public company must file a proxy.

Last year, Faruqi & Faruqi filed a suit against AAR Corp. in federal court in Chicago, seeking additional details on how the aerospace company chose its compensation consultant and peer group for comparisons, and why one executive’s pay appeared to differ from that of other executives.

“This is a hold-up,” AAR’s attorneys wrote in court papers responding to the suit, which sought to halt the company’s nonbinding “say on pay” vote. The company’s attorneys argued that 40 pages of AAR’s 70-page proxy dealt with executive compensation and that proxy adviser Glass Lewis & Co had noted its disclosure was “exemplary” that year. The court denied the plaintiff’s request to block the shareholder vote, and AAR is seeking to have the suit dismissed.

Some companies, including Microsoft Corp., argue that demands for additional disclosures are pointless. In October, Faruqi & Faruqi attorneys filed a lawsuit seeking to block the software company’s annual meeting and force it to release a report prepared by its pay consultant, as well as more information about compensation at its peer-group companies and internal memos related to executive-pay discussions.

In response, Anne Sheehan, director of corporate governance at the California State Teachers’ Retirement System, and one of Microsoft’s biggest shareholders, filed a declaration with the court, saying she already found Microsoft’s disclosures “sufficient.” The suit was withdrawn in November, and Microsoft got more than 90% support on proxy proposals at its annual meeting.

“These cases don’t serve the best interests of shareholders,” a Microsoft spokesman said.

But the suits have accelerated as some companies have agreed to cash settlements. Last April, Faruqi & Faruqi won an injunction from a California judge that would have prevented networking-gear maker Brocade Communications Systems Inc. from holding a shareholder vote at its annual meeting. Just before the meeting date, Brocade settled for $625,000 and agreed to more disclosures about how it planned to replenish shares used for employee pay. It ended up getting support for its plan from around 60% of the shares voted.

Companies are watching the lawsuits closely, but also are wary of making changes in their disclosures, out of fear that tweaks could attract more attention, send them out of line with their peer groups or bring new demands for further disclosure.

Faruqi & Faruqi, meanwhile, shows no signs of backing down. “You could provide 500 pages [of disclosures] and it would be meaningless–you need to provide quality and not quantity,” said Mr. Monteverde.

Comments (3 of 3)

My cousin, the Informed Shareholder, is a partner in the plaintiff law firm identified in the article.

12:37 pm February 5, 2013

James McRitchie wrote:

I understand the average settlement for disclosure-only cases is about $400,000 – $600,000. Re Say-on-Pay II, which involves trying to enjoin the shareowners meeting based on disclosures, I understand they's lost in every case litigated. Plaintiffs can’t demonstrate irrepairable harm. Many argue companies have to stop settling even if the average cost is around $125,000 per settlement. Others argue, if the cost of litigation exceeds the cost of settlement, it pays to settle.

Over time, I would hope to see some better legal guidelines that make it more easily to dismiss frivolous cases but which encourage those with merit.

11:20 am February 5, 2013

Informed Shareholder wrote:

full disclosure is all we can ask for. I think there is a lot of benefit to this type of litigation.

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